SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1996 Commission file number 0-26596 Computational Systems, Incorporated ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) Tennessee 62-1198047 - - ----------------------------- ------------------------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Identification No.) Organization) 835 Innovation Drive Knoxville, Tennessee 37932 - - ----------------------------- ------------------------- (Address of Principal (Zip Code) Executive Office) Registrant's Telephone Number, Including Area Code: (423) 675-2110 	 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Common Stock outstanding - 4,785,264 shares at April 25, 1996 PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements. - - ------------------------------------------------------------------- Consolidated Condensed Balance Sheets Consolidated Condensed Statements of Operations Consolidated Condensed Statements of Cash Flows Notes to Consolidated Condensed Financial Statements COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS MARCH 31, DECEMBER 31, 1996 1995 (unaudited) ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 8,560,870 $ 8,824,332 Accounts receivable, less allowance for doubtful accounts 9,426,601 9,980,006 Inventories 3,829,031 3,623,124 Other current assets 1,188,782 1,102,369 ----------- ----------- Total current assets 23,005,284 23,529,831 ----------- ----------- Property, plant and equipment: Land 729,204 729,204 Building and improvements 4,503,622 4,488,421 Equipment and furniture 7,940,805 6,850,428 ----------- ----------- 13,173,631 12,068,053 Less accumulated depreciation (4,449,785) (4,129,812) ----------- ----------- Total property, plant and equipment, net 8,723,846 7,938,241 ----------- ----------- Other assets, including intangibles 719,141 682,701 ----------- ----------- Total assets 32,448,271 32,150,773 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt 18,771 18,377 Accounts payable and other current liabilities 2,923,217 2,610,363 Accrued liabilities 3,880,227 4,469,251 ----------- ----------- Total current liabilities 6,822,215 7,097,991 Long-term debt, less current maturities 6,957 13,172 Deferred maintenance contract revenue 530,042 512,159 ----------- ----------- Total liabilities 7,359,214 7,623,322 =========== =========== Shareholders' equity: Common stock, no par value, 50,000,000 shares authorized, 4,763,264 and 4,743,209 shares issued and outstanding in 1996 and 1995, respectively 15,518,802 15,459,192 Additional paid-in capital 815,862 815,862 Retained earnings 8,754,393 8,252,397 ----------- ----------- Total shareholders' equity 25,089,057 24,527,451 ----------- ----------- Total liabilities and shareholders' equity $32,448,271 $32,150,773 =========== =========== The accompanying notes are an integral part of these consolidated condensed financial statements. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended March 31, March 31, 1996 1995 ----------- ----------- Revenues, net: Product $7,932,848 $7,032,959 Services 2,798,445 2,321,521 ----------- ----------- 10,731,293 9,354,480 ----------- ----------- Cost of revenues: Product 2,316,055 2,398,507 Services 2,180,255 1,729,581 ----------- ----------- 4,496,310 4,128,088 ----------- ----------- Gross margin 6,234,983 5,226,392 ----------- ----------- Costs and expenses: Selling , general and administrative 4,355,000 3,593,320 Research & development 1,206,196 1,078,435 ----------- ----------- 5,561,196 4,671,755 ----------- ----------- Income from operations 673,787 554,637 ----------- ----------- Other income (expense) Interest expense (1,146) (145,134) Interest income 117,589 28,850 Other income (expense), net (5,859) 22 ----------- ----------- 110,584 (116,262) ----------- ----------- Income before taxes 784,371 438,375 Provision for income taxes 282,375 157,815 ----------- ----------- Income after taxes $501,996 $280,560 =========== =========== Earnings per share $0.10 $0.08 Weighted average shares and equivalents outstanding 5,018,945 3,540,848 =========== =========== The accompanying notes are an integral part of these consolidated condensed financial statements. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (unaudited) Three Months Ended March 31, March 31, 1996 1995 ---------- ---------- Cash flows from operating activities: Net income $501,996 $280,560 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 403,656 275,325 Deferred income taxes (176,000) (65,000) Changes in operating assets and liabilities: Accounts receivable 553,405 57,366 Income taxes refundable (payable) (72,073) (226,673) Inventories (264,864) 97,739 Prepaids 71,587 7,911 Other assets (40,703) (3,057) Accounts payable (16,760) (183,973) Accrued liabilities (516,951) (219,582) Deferred maintenance contract revenue 347,497 232,891 ---------- ---------- Net cash provided by operating activities 790,790 253,507 ---------- ---------- Cash flows from investing activities: Purchase of property, plant and equipment (1,108,041) (585,313) Notes receivable from shareholders ------ (10,712) ---------- ---------- Net cash used in investing activities (1,108,041) (596,025) ---------- ---------- Cash flows from financing activities: Net borrowings under (repayments on) line of credit ------ 414,000 Repayments of long-term debt (5,821) (45,091) Proceeds from issuance of common stock 59,610 123,770 Purchases of common stock ------ (22,760) Checks outstanding in excess of bank balances ------ (43,388) ---------- ---------- Net cash provided by financing activities 53,789 426,531 ---------- ---------- Net increase (decrease) in cash and cash equivalents (263,462) 84,013 Cash and cash equivalents, at beginning of period 8,824,332 ----- ---------- ---------- Cash and cash equivalents, at end of period $8,560,870 $84,013 ========== ========== The accompanying notes are an integral part of these consolidated condensed financial statements. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. INTERIM FINANCIAL STATEMENTS: Information in the accompanying financial statements and notes to the financial statements for the interim periods is unaudited. The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 1996, are not necessarily indicative of the results that may be expected for the year ended December 31, 1996. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for December 31, 1995. 2. INVENTORIES: 	Inventories consist of the following: March 31, December 31, 1996 1995 ---------- ---------- (Unaudited) Raw Materials $1,834,384 $1,835,885 Work in-process 875,706 736,109 Finished goods, net 1,118,941 1,051,130 ---------- ---------- $3,829,031 $3,623,124 ========== ========== 3. CASH FLOW INFORMATION: March 31, March 31, 1996 1995 ---------- ----------- (Unaudited) Supplemental disclosures of cash flows: Interest paid $ 1,473 $ 121,655 ========== =========== Income taxes paid, net $ 461,899 $ 400,000 ========== =========== 4. RESEARCH AND DEVELOPMENT: Research and development costs are expensed as incurred. Costs incurred in developing a product during the period that begins when the product's technological feasibility has been established and ending when the product is available for general release are capitalized and amortized over the economic life of the product. Historically such costs have not been material. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Comparison of Three Months Ended March 31, 1996 and March 31, 1995 Revenues, Net. Total revenues increased 14.7% in the three months ended March 31, 1996 ("the 1996 quater") to $10.7 million, compared to $9.4 million during the three months ended March 31, 1995 ("the 1995 quarter"). Revenues from the sale of products increased 12.8% to $7.9 million in the 1996 quarter from $7.0 million in the 1995 quarter. The increase in product revenues is due primarily to market acceptance of a balancing product which was introduced in the 1995 quarter and the introduction of a new motor product in the 1996 quarter. Service revenues increased 20.6% to $2.8 million in the 1996 quarter from $2.3 million in the 1995 quarter primarily as a result of the opening of an oil analysis lab in Knoxville as well as an increased emphasis in the maintenance contracts area. Cost of Revenue. Total costs of revenues increased 8.9% to $4.5 million in the 1996 quarter from $4.1 million in the 1995 quarter. As a percentage of net revenues, total cost of revenue decreased from 44.1% in the 1995 quarter to 41.9% in the 1996 quarter. Product costs decreased 3.4% to $2.3 million in the 1996 quarter from $2.4 million in the 1995 quarter primarily due to favorable pricing that resulted from purchasing negotiations, decreased labor hours required in the manufacturing process and other efficiencies and improvements which were derived from the Company's ISO 9002 processes. Service costs increased 26.1% to $2.2 million in the 1996 quarter from $1.7 million in the 1995 quarter primarily due to an increase in the number of field service locations. Services costs associated with the Company's service business are accounted for almost entirely in cost of revenue. Selling, General and Administrative. SG&A expense increased 21.2% to $4.4 million in the 1996 quarter from $3.6 million in the 1995 quarter. The increase was due primarily to an increase in market development expenditures such as an increase in the number of marketing regions and related personnel, as well as the continuing shift from independent sales representatives to employee sales representatives. SG&A expense, as a percentage of net revenues, increased to 40.6% in the 1996 quarter from 38.4% in the 1995 quarter. Research and Development. Research and development expenses increased by $127,761 or 11.8% to $1.2 million in the 1996 quarter from $1.1 million in the 1995 quarter, reflecting net additions to the Company's staff in support of a more diverse product line. As a percentage of net product revenues, however, research and development expenses declined to 15.2% in the 1996 quarter from 15.3% in the 1995 quarter. Income from Operations. Income from operations for the 1996 quarter increased 21.5% to $673,787 or 6.3% of net revenue, from $554,637, or 5.9% of net revenue, in the 1995 quarter. Total operating expenses increased by $889,441 or 19.0% to $5.6 million in the 1996 quarter from $4.7 million in the 1995 quarter. Interest Expense/Income. Interest expense decreased in the 1996 quarter to $1,146 from $145,134 in the 1995 quarter, primarily as a result of the retirement of debt and the line of credit from the proceeds of the Company's Initial Public Offering (IPO) in August 1995. Interest income increased 307.6% in the 1996 quarter to $117,589 from $28,850 in the 1995 quarter due to proceeds from the IPO being invested in short-term government securities that bear interest at approximately 5% per anum. Income Taxes. The Company's effective tax rate for the 1996 and 1995 quarters was approximately 36.0%. Liquidity and Capital Resources Since its inception, the Company has financed its operations through a combination of cash flow from operations, bank borrowings and equity capital. The Company's capital requirements have arisen primarily in connection with purchases of fixed and intangible assets, including acquisitions, and the Company makes significant expenditures each year for research and development and market development. Net cash provided by operating activities in the 1996 quarter increased to $790,790 from $253,507 in the 1995 quarter primarily due to increases in net income and collections of accounts receivable that were directly related to a 15% increase in sales and increases in accrued liabilities that reflect the higher level of business activity. Investing activities primarily include additions to property, plant and equipment. The Company maintains a bank line of credit that provides for borrowings of up to $4.0 million based on a current ratio of 1.25 or better and bears interest at the lender's base rate. The Company's total liabilities decreased to $7.4 million as of March 31,1996 as compared to $7.6 million as of December 31, 1995 due to the reversal of various 1995 accrued expenses. Although the Company has presently neither acquisition agreements nor arrangements, the Company may in the future make strategic acquisitions of other providers of maintenance products or services using stock, cash, debt or a combination thereof. Depending on the terms of the acquisition, the Company may need to incur additional indebtedness or issue equity securities to make any such acquisition. The Company routinely engages in transactions in foreign countries. Substantially all of the Company's transactions are denominated in U.S. currency, thereby limiting the Company's exposure to fluctuations in foreign currency exchange rates. Results of Operations The following table sets forth the percentage relationships to net revenues of certain statements of operations data, for the periods indicated. Percentage of Revenues, Net Three Months Ended March 31, March 31, 1996 1995 -------- -------- Revenues, net: Product 73.9% 75.2% Services 26.1% 24.8% -------- -------- Total 100.0% 100.0% Cost of revenues: Product 21.6% 25.6% Services 20.3% 18.5% -------- -------- Total 41.9% 44.1% Gross margin 58.1% 55.9% Operating expenses: Selling , general and administrative 40.6% 38.4% Research & development 11.2% 11.5% -------- -------- Total 51.8% 49.9% -------- -------- Income from operations 6.3% 6.0% Other income (expense) Interest expense -0.0% -1.6% Interest income 1.1% 0.3% Other income (expense), net -0.1% 0.0% -------- -------- Total 1.0% -1.3% -------- -------- Income before provision for income taxes 7.3% 4.7% -------- -------- Provision for income taxes 2.6% 1.7% -------- -------- Net income 4.7% 3.0% ======== ======== PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K - - ------------------------------------------------------------------------------- 	(a)	Exhibits: (11) Statement re: computation of per share earnings (b) No reports on Form 8-K were filed for the quarter ended March 31, 1996 SIGNATURES Pursuant to the requirments of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMPUTATIONAL SYSTEMS, INCORPORATED Date: By: /s/Ronald G. Canada ----------------------------------- Ronald G. Canada, Chairman and Chief Executive Officer By: /s/Bryan J. Collier ----------------------------------- Bryan J. Collier, Vice President of Finance and Chief Financial Officer Exhibit Index Sequential Item Description Page No. - - ------------- ----------------------------------------------- ---------- (11) Statement re: Computation of per share earnings EXHIBIT 11 - EARNINGS PER SHARE THREE MONTHS ENDED ----------------------- MARCH 31, MARCH 31, 1996 1995 ---------- ---------- PRIMARY: Weighted average number of common shares outstanding 4,752,611 3,352,040 Net effect of dilutive stock options based on the treasury stock method using the average market price 266,334 188,808 ---------- ---------- Weighted average number of common and common equivalent shares outstanding 5,018,945 3,540,848 ========== ========== Net income $501,996 $280,560 Primary net income per common share as reported $0.10 $0.08 FULLY DILUTED: Weighted average number of common shares outstanding 4,752,611 3,352,040 Net effect of dilutive stock options based on the treasury stock method using the period-end market price if higher than average price 272,174 188,808 ---------- ---------- Weighted average number of common and common equivalent shares outstanding 5,024,785 3,540,848 ========== ========== Net income $501,996 $280,560 Fully diluted net income per common share as reported $0.10 $0.08 The difference between fully diluted earnings per share and primary earnings per share is immaterial. Therefore, fully diluted earnings per share have not been disclosed in the financial statements.